What's The Best Way to Invest for Your Grandchildren's College Education?

Dear Carrie: I have $85,000 to invest for my grandchildren's education. Where would you suggest I invest it? -- A Reader

Dear Reader: I applaud your idea wholeheartedly, with just one caveat. Before you move ahead, make absolutely sure you won't need that money for your own retirement. Err on the cautious side, and proceed with this gift to your grandkids only if you're confident you'll have the financial resources you'll need for yourself. You are being incredibly generous, but when it comes to retirement, it's hardly selfish to think of yourself first!

That said, let's get to the meat of your question. Essentially, you're looking at four options: a 529 plan, a custodial account, a trust account, or simply investing using your own account (with the plan to make gifts to your grandchildren later).

The 529 plan: The most obvious answer, but not necessarily the right one, is a 529 plan -- the popular tax-deferred vehicle for college investing. (A Coverdell Education Savings Account can offer even greater benefits, but is limited to annual contributions of no more than $2,000 and then only if you qualify based on your adjusted gross income.) In a 529 account, investment income is never taxed, as long as it's withdrawn for "qualified" higher education expenses. Qualified means about what you'd expect: tuition and fees, room and board, and books and supplies.

--You can make substantial contributions without triggering gift taxes. An individual can contribute $65,000, and a married couple can give $130,000 in a single five-year period (this requires a special election on your gift tax return).

--You control the assets. The child is the beneficiary, but the assets are in your name; your grandkids cannot access the money directly.

--You can transfer unused assets to a wide range of family members, which could be important. Say one grandchild was college bound, but the other wasn't; 529 plan assets could be shifted to the one headed for college without penalty.

--You might get a state tax break. Some states offer tax credits for 529 contributions.

So what's not to like? Well, 529 plans offer fewer investment choices than custodial accounts or trusts, and trading and exchanges are often limited. Plus, the funds can only be used for higher education. If you withdraw them for some other reason, you'll pay federal and state taxes on any investment income plus a 10 percent penalty.

A Custodial Account: If you're sure your grandkids will go to college, a 529 plan makes sense. But if your goal is simply to give them some financial assistance later in life, you might consider a custodial account. It's more flexible than a 529 in terms of what you can invest in and how your grandkids can use the money.

That can be a double-edged sword. You would control the investment now, but the assets must be given to the beneficiary when he or she turns 18, 21 or 25 (depending on your state and your wishes). Theoretically, your grandchild could reach the legal age and cash out the account to buy a Ferrari, and there'd be nothing you could do about it.

Earnings don't grow tax-free as they do with a 529 plan, but a custodial account may offer a tax benefit. Under the current tax code, the first $950 of investment earnings is tax-free and the next $950 is taxed at the child's, usually quite low, rate. After that, the marginal tax rate goes up to the parents' rate.

A Trust Account: If you want more control over the money, look at a trust account, either a Crummey Trust (the odd name comes from the first person who successfully set one up) or a 2503(c) Minor's Trust. These are more complex and more expensive than your other options. If they sound appealing, consult a trust expert to see if one of these structures would be right for you. With either a custodial account or a trust account, you will be limited to the annual gift tax exclusion of $13,000 per year per recipient ($26,000 for spouses electing to "split" their gifts).

Keep It in Your Own Account: One final option is simply to earmark that money for your grandchildren and keep it in your own name and your own account. Of course, you would need to stipulate your intentions in your will (or set up a trust), and potentially have part of it eaten up by estate tax. But the pluses are that you'll have complete control over how the money is invested and how and when it's disbursed. In addition, if you should happen to need the money yourself, it'll be available.

So you have a lot of options, though given the amount of money you plan to invest and assuming you are very confident you won't need it yourself, the 529 plan may make the most sense. Pick a plan with low expenses and a wide range of investment choices. Then make investment choices that match the time horizon you need and offer plenty of diversification. Target funds, which rebalance automatically as the date of matriculation grows nearer, offer a simple solution, so check them out.

Good luck -- and I am sure your generosity will be remembered for years and years to come.

“One of their arguments is that the Army needs more personnel than the Air Force and there is a possibility that mid-way through college the Air Force will determine that they’re ‘overstaffed’, will not need new officers, and will discontinue his scholarship. I wonder if that’s true?”

You might get some good answers to that on a military forum like military.com, or google for “military forum” and you will probably find many.

I just read a story that the military is considering laying off a huge number of people, something like 100,000 people. I think I saw the article here sometime in the past week or two. I don’t remember what branch of service it was.

“A friend of mine knows how to use heavy machinery. No college at all. He makes $100K+ a year.”

You people who keep preaching on about trades (plumbing work and here, operating heavy machinery), you present one helluva an assumption, that the people you want to do this have mechanical ability. And damn it, not everyone does; I’d say few do. So, you’re trying to put the old square rod into the round hole. And they don’t always fit, folks!

That is fine if someone doesn’t have the aptitude for the trades, that is what college is for. The bigger problem is for the last 30 years or so this type of work has been made fun of and made socially unacceptable. Even when I was a kid, the Votech kids were ridiculed overall for being a lower social status so much that no sensible person would go even if they would rather do that then take the college prep classes. Work like this should get equal importance and respect so that kids feel they can go this direction and succeed quite well.

Even the way our Gov’t handles this stuff encourages this thinking. Look at all these stupid Gov’t programs that have been pushed by Clinton, Bush II and Obummer for the unemployed and the intercity poor. Free or near free college. Retraining for unemployed with college programs. Remember in the 90’s when everyone and their brother was a computer programmer? How many of those did we need? Not many judging how most had to back and do something else. What about focusing on other jobs we need. I am a slumlord and I can tell you that there is a shortage of well trained people in the trades to take over for all the old timers hanging up their tools.

Even if you end up going to college, the problem with my contemporaries in their 30’s and 40’s is that they have absolutely no idea how a screw driver works. When I was a kid, the neighborhood accountant or teacher could at least change a tire or handle light repairs around the house or even cook themselves a meal. Now I have friends who look at me as some sort of wizard because I can install a dishwasher. They are constantly calling the dwindling numbers of blue collar people to do it for them. This is not how the US operated in the past and will not help us get back on out feet. It is time to encourage people getting into these fields again.

Well-stated, sir.

I agree that manual work, even the highly skilled trades, has been made fun, completely unjustifiably so.

I have nothing but admiration for those who are capable of doing such work. Those folks really make the world go ‘round in my opinion and they deserve our respect.

I was just pointing out that not everyone has the capability of succeeding in such work.

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